The stocks that could help you live your dreams... - The 5 Minute WrapUp by Equitymaster
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The stocks that could help you live your dreams...

Aug 10, 2015

In this issue:
» Indian markets one of the most expensive among emerging economies
» Do MNCs deserve the premium valuations they are commanding?
» Round up on the markets
» ...and more!

"Hey.. I'm finally getting married." Proclaimed my fellow local train commuter who is also a friend. She should have been excited to have finally got her parents' approval to get married to the guy she has been wanting to for years. However, her tone hardly suggested so. "Why do you sound so sad?", I asked. It turned out, she has been spending weekends on house hunt with her fiance. Being a little averse to the idea of rented accommodation, she has been trying to buy a home. But with the prohibitive prices, is on the verge of giving up on hope of having her own home. "Forget it, I don't think I can ever afford one" was how she diverted the topic that she seemed too tired to discuss.

For an average salaried person, without a generous inheritance, buying a house can be a lifelong dream. But not if you have planned your savings and investments well enough to fulfill this dream.

Consider the case of this other friend of mine who, within 10 years of being employed could afford to own a house. That too without any bank loan! And not just that. He is already planning an early retirement, devoting a lot of his time to bucket list... and what not! How did he manage to do what most of us can only dream of.

Well, he has been an active and disciplined investor in stock markets. Since the start of his career, he has been actively investing in stocks. And while benchmark index has yielded around 271% returns (14% per annum on a compounded growth rate basis) over this time, what made this feat possible was investment in chunk of small cap stocks the percentage returns on which have been in three and four digits. Some of these stocks have, over the last decade, stepped up indices and are a part of midcap index now.

Sounds great, doesn't it? However, before you get enamored with the idea, here is something you must know. Small cap stocks, within equities, form the asset class with highest risks. Low liquidity, lack of transparency, lesser available knowledge about the managements, business and track record are some of the issues to begin with. Unlike the mid cap and large cap peers which are well tracked and on everybody's radar - be it the regulator, big investors and analysts; small cap stocks offer no such comfort. Hence, to unlock the opportunity that small cap stocks can offer, one needs to be very diligent in analyzing the business potential and risks. Not just business, but management quality as well. Given the limited disclosures, this is indeed a daunting task.

However, a thorough research on smallcaps, if done well, is worth the effort.

Being associated with smallcap research via The Hidden Treasure, for years now, I can certainly vouch for it. I and my team have enough tools and sources to facilitate the research on such undiscovered companies. Having a team devoted to researching stocks in the small space ensures that no biases creep in. Most importantly, it is not just good businesses, but the ones with attractive valuations that we chase. Meeting managements across the length and breadth of the country gives us enough scope to reject most and select the handful that filter through our checklist. With all these factors supporting our efforts, we have witnessed several small cap recommendations become multibaggers overtime.

At times we have made mistakes too. Some of the stocks have not performed as expected . However, with all that goes into final recommendation, our successful calls have far outweighed the failures. Not to mention the quantum of returns that have been overwhelming. In fact, some of the stocks have offered returns that are unmatchable by any other asset class.

So if you are seeking mega returns, small cap is the space you cannot afford to miss. The key is to follow bottom up strategy and identify the stocks with strong business models and sustainable moats without overpaying for them, and holding on to the winners. What is also needed is a well diversified portfolio and patience.

However, this is easier said than done. The problem is that by the time retail investors spot such businesses, the valuations are already stretched. Even if they are lucky enough to invest at the right time, exit at a wrong time leads to huge opportunity losses.

Speaking of current scenario, the small cap index has more than doubled over last two years. While this could be a function of both earnings growth and re rating, the speculative component is a bigger driver for the surge in the stock prices in this space. As too much money is chasing the stock market, a lot of stocks in this space have already been the biggest gainers over the last quarter. A lot of them of them undeservedly so.

But as I said, with sufficient research and patience, the chances of success and quantum of returns are lucrative enough. The good part is that there are still enough mispriced opportunities in space. I and my team have identified some such stocks that are undisputed leaders and trendsetters in their respective niches. We have met their managements and have been tracking them for quite some time. We will be coming up with a list of such stocks very soon for Hidden Treasure subscribers. And we hope that these will contribute to some extent in making their dreams come true.

Do you agree that with due diligence, investing in small cap stocks can help you fulfill all your dreams? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
When you invest, do you prefer home-grown companies or MNCs?

We came across an article in Business Standard that reported some interesting statistics by Ambit Capital. In the said article, the brokerage firm compared the performance of the MNC stocks with the BSE-500 over varying time periods. And guess what the results were? Had you invested in MNC stocks instead of home-grown companies, you portfolio would have compounded at a much higher rate.

The chart of the day shows how the NSE MNC index has performed vis-a-vis the benchmark Nifty index over the last 10 years. While the performance was a mixed bag during the first five years, during the latter half MNC stocks have been clear winners.

What are the factors that have driven MNC stock prices way ahead of domestic companies? Particularly, the rise in the MNC index is a lot more pronounced in recent years. What is the reason for this? Apparently, it turns out that the key driver of better stock price performance has not been higher earnings growth. Then what is it that has caused valuations of MNC stocks to increase so much? We believe that one of the key reasons for the high MNC valuations is the safe haven status that many wide moat MNC companies enjoy because of solid business fundamentals, high returns on capital, etc. Investors tend to be willing to pay lofty valuations in exchange for a so-called ‘safe’ investment.

In our view, it would be a bit risky to rush now and invest in MNC stocks simply because they have delivered superior returns in the past. Stock valuations often tend to go through cycles of expansion and contraction. Investing in a safe business at expensive valuations is not a very safe approach we believe. The best time to invest is always when valuations are still in the contraction cycle and there is widespread pessimism in the market. Go looking for great businesses during such times and you are highly unlikely to lose money.

Are MNC Stocks Your Best Investment Bet?

Crude oil prices... This is one of the key macroeconomic factors that we feel could be the harbinger to India's economic recovery. Let us explain it with some numbers...

As per an article in Business Standard, every time crude oil prices dip by US$ 1 our import bill goes down by Rs 65 billion! The government's subsidy burden declines by Rs 9 billion. This means that if crude oil prices sustain at lower levels, it could result in big savings for India, a big importer of crude oil.

Currently, the Indian crude basket is at US$ 49.11 per barrel. This is the lowest level since January 30 when the Indian basket stood at US$ 46.28. The average price in the fiscal year 2015-16 so far has been US$ 58 per barrel. The Indian government had budgeted for an average crude oil price of US$ 70 per barrel for the financial year. So if the crude prices sustain at the US$ 58 level for the rest of the financial year, we will have savings of US$ 12 per barrel. Overall, it would result in a saving of Rs 780 billion in companies' import bill and about RS 108 billion in the government's subsidy bill. These huge savings could result in lower inflation and could also be productively channelized in the economy to drive growth.

What are the factors driving crude oil prices lower? The reasons seem many. One there has been higher drilling activity and stockpile in the US. Two, a strong dollar. Three, the slowing Chinese economy. And lastly, the likelihood of Iran ramping up its crude oil production after sanctions on the country were lifted recently. Given these factors, it appears that crude oil prices are unlikely to rebound anytime soon.

The Indian stock markets continued to trade in the positive territory after opening the day on a positive note. At the time of writing, the BSE-Sensex was trading higher by 106 points (up 0.4%). Gains were led by stocks in the realty and IT sector. Metal stocks were however were trading in the red.

  Today's investing mantra
"It's waiting that helps you as an investor, and a lot of people just can't stand to wait. If you didn't get the deferred-gratification gene, you've got to work very hard to overcome that." - Charlie Munger.

This edition of The 5 Minute WrapUp is authored by Richa Agarwal (Research Analyst) and Ankit Shah (Research Analyst).

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3 Responses to "The stocks that could help you live your dreams..."

M Baskaran

Aug 23, 2015

yr article has been a trigger for thinking process!the main point is fear and greed and to control both is going to be challenging... Im a member of hidden treasure - recently joined ... let me see for some time how yr people's analysis goes! I am taking a calculated risk and i hope u will do well since yr full time work is analysis of the hidden gems!



Aug 11, 2015

Very thought provoking


Prakash Gurba

Aug 10, 2015

As far as I know, Equitymaster has close association with Quantum MF. You seem to be full of ideas for mid and small cap stocks.But what I wonder is that Quantum MF has not yet started any mid & small cap fund.o far. Then why you feel that retailers should show courage and invest in mid and small caps ?.

Equitymaster requests your view! Post a comment on "The stocks that could help you live your dreams...". Click here!
Equitymaster Agora Research Private Limited (hereinafter referred to as "Equitymaster"/"Company") was incorporated on October 25, 2007. Equitymaster is a joint venture between Quantum Information Services Private Limited (QIS) and Agora group. Equitymaster is a SEBI registered Research Analyst under the SEBI (Research Analysts) Regulations, 2014 with registration number INH000000537.

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